The S&P 500 Goes Supernova

The S&P 500 Goes Supernova

By Jared Kizer I think most investment professionals are generally aware of how well the S&P 500 has done relative to virtually every other asset class since the end of the global financial crisis (GFC). A bit more precisely, the S&P 500 is up 352 percent from March 2009 through October 2018 while international developed stocks, emerging markets stocks and bonds are up 140, 142 and 39 percent, respectively. What you might be surprised to know though (I certainly was) is that it’s almost impossible to simulate another same-length period where the S&P 500 had better risk-adjusted returns. In other words, saying the S&P 500 has done well during this period is a gargantuan understatement. As we will see, it’s done so well that it’s reasonable to ask whether anyone alive will ever experience a better performance period for U.S. large-cap stocks. The last sentence may sound extreme, but I think returns data for the S&P 500 illustrates just how mind-blowingly astounding the post-GFC returns experience has been. Using a technique called bootstrapping (also referred to as re-sampling), you can take the entire historical returns history for any asset class and build out an extremely large number of alternate histories of any length. For example, you can use the entire monthly returns history of U.S. small-cap stocks to build out 100,000 unique, 10-year-length histories to get a sense of what’s theoretically possible, performance-wise, over a 10-year period. As you might guess, bootstrapping is very similar to Monte Carlo simulation with the key difference being that bootstrapping directly utilizes historical data as opposed to simulating returns according to a particular...
Temperament Trumps Intellect in Investing

Temperament Trumps Intellect in Investing

By Larry Swedroe Legendary investor Warren Buffett famously stated: “Success in investing doesn’t correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people in trouble investing.” The reason temperament trumps intellect is that having the right temperament is what allows you to ignore the “noise” of the market and be a patient, disciplined investor, adhering to your well-thought-out plan through the inevitable bad times—times when even good strategies deliver poor outcomes. What does it take to be an investor whose temperament allows you to be patient and disciplined? My almost 25 years of experience as an advisor has taught me that there are seven keys to success. The first—and most important—one is that you need to understand the nature of the risks of an investment before you commit to it. 1. Understanding the Nature of Risks Before Investing When investment strategies are working, delivering positive returns, it’s relatively easy to stay the course. However, your ability to withstand the psychological stress that negative returns (or even relative underperformance) produces is inversely related to your level of understanding of the nature of risks of an investment. That means you have to understand the sources of risk (what could cause returns to turn negative or be below expectations) and return for an investment. You should also understand how the risks of each investment correlate with the risks of other investments in your portfolio (whether correlations tend to rise or fall when your other portfolio assets are doing poorly). 2. Know Your Investment History To paraphrase a noted Spanish philosopher,...
Be Prepared for Losses

Be Prepared for Losses

By Larry Swedroe The stock premium—the annual average return of stocks minus the annual average return of one-month Treasury bills—has been high, attracting investors to the stock market. For the period 1927–2017, it averaged 8.5%. There have also been size (return of small stocks minus return of large stocks) and value (return of value stocks minus return of growth stocks) premiums of 3.24% and 4.82%, respectively. However, the excess returns are generally referred to as risk premiums—they aren’t free lunches. We see evidence of that in the volatility of the premiums. The stock, size and value premiums have come with annual standard deviations of 20.41% (2.4 times the stock premium), 13.78% (4.3 times the size premium) and 14.20% (2.9 times the value premium), respectively. Let’s take a closer look at some of the data that illustrate the riskiness of the premiums. For the period: The stock premium was negative in 27 of the 91 years (30% of the years). There were 17 years (19% of the years) when the premium was worse than -10%, 12 years (13% of the years) when it was worse than -15% and seven years (8% of the years) when it was worse than -20%. As another indicator of the volatility of the stock premium, we see that the gap between the best and worst years was 102.2%, more than 12 times the size of the premium itself. The worst year was 1931, when the premium was -45.11%. Given a premium of 8.5% and a standard deviation of 20.41%, this was more than a 2.5 standard deviation event. The best year was 1933, when the premium was 57.05%, also more than two standard deviations from the mean. In fact, we had six such two-standard-deviation events. We would have had just four if the returns had been normally distributed....
Mutual Fund Benchmark Discrepancies Can Fool Investors

Mutual Fund Benchmark Discrepancies Can Fool Investors

By Larry Swedroe Evaluating the performance of actively managed mutual funds generally involves comparing a product’s results with some passive benchmark (the SEC requires that funds select a benchmark for comparison purposes) that follows the same investment “style” as the fund’s portfolio (such as the S&P 500 for large-cap stocks, the S&P MidCap 400 for midcap stocks and the S&P SmallCap 600 for small-cap stocks). This practice can create problems, as funds can choose benchmarks with less exposure than they do to factors that historically have provided premiums (such as market beta, size, value, momentum, profitability and quality). Thus, the benchmarks have lower expected returns. This misleading practice is important because, as Berk Sensoy’s study, “Performance Evaluation and Self-Designated Benchmark Indexes in the Mutual Fund Industry,” which appeared in the April 2009 issue of the Journal of Financial Economics, shows, “almost one-third of actively managed, diversified U.S. equity mutual funds specify a size and value/growth benchmark index in the fund prospectus that does not match the fund’s actual style.” Unfortunately, the same research also shows that when allocating capital, individual investors emphasize comparisons relative to the mutual fund’s self-selected benchmark, not its true, risk-adjusted benchmark. It’s clear that fund companies strategically choose a benchmark that will drive fund flows. Recent Research Martijn Cremers, Jon Fulkerson and Timothy Riley contribute to the literature on mutual fund performance relative to self-selected benchmarks with their May 2018 study, “Benchmark Discrepancies and Mutual Fund Performance Evaluation.” They used a holdings-based procedure to determine whether an actively managed fund has a “benchmark discrepancy”; that is, a benchmark other than the prospectus benchmark that better...
Know Your Risk Inclinations and Investor Personality

Know Your Risk Inclinations and Investor Personality

By Larry Swedroe In my book, “The Only Guide You’ll Ever Need for the Right Financial Plan,” there’s a detailed discussion on how investors can choose the right asset allocation for them, with the focus being on determining one’s ability (capacity), willingness (tolerance) and need (the rate of return required to achieve a goal) to take risk. To help with issues surrounding the willingness to take risk, risk tolerance questionnaires have become a very popular. Unfortunately, as Joachim Klement showed in his article, “Investor Risk Profiling: An Overview,” published in the June 2018 CFA Institute Research Foundation brief “Risk Profiling and Tolerance: Insights for the Private Wealth Manager,” the “current standard process of risk profiling through questionnaires is found to be highly unreliable and typically explains less than 15% of the variation in risky assets between investors. The cause is primarily the design of the questionnaires, which focus on socioeconomic variables and hypothetical scenarios to elicit the investor’s behavior.” He went on to explain that there are three problems questionnaires typically fail to address: Our genetic predisposition affects our willingness to take on financial risks, the people we interact with shape our views, and the circumstances we experience in our lifetimes—in particular, during the period psychologists call the formative years—influence our outlook. Being aware of biases at least gives us a chance of addressing them, either on our own or with the help of a financial advisor. Michael Pompian provides guidance on behavioral biases in his article, “Risk Profiling Through a Behavioral Finance Lens,” for the aforementioned CFA Institute Research Foundation brief. (Pompian also is the author of the 2012...
Dealing With an Investing Blind Spot

Dealing With an Investing Blind Spot

By Carl Richards Psst. Excuse me. I’ve got a secret. I feel like I should be talking really quietly right now, but first I need to warn you. This secret is going to seem incredibly obvious. You may even wonder why I’m going to tell you about it at all. The secret comes in two parts: 1. We all have blind spots. 2. By definition, we can’t see them. See what I mean about being obvious? They’re called blind spots for a reason, because you can’t see them. But here’s the real tragedy: We’re often totally uncoachable when it comes to dealing with this secret. I know this is true because I’ve experienced it myself. For months, my trainer was trying to help me solve a stomach issue. He suggested I keep a food journal to see if my symptoms pointed to an allergy. For months, I refused. I already know what I’m eating. I don’t need to write it down in a journal. Sound familiar? Trust me. You have blind spots, and it’s really hard to be objective about our own behavior. But there is hope, and the solution is simple, if not easy to do. We need to be coachable. We need to find, and then listen to, other people who can see our blind spots. A friend of mine, a retired investment banker, did just that himself. This guy knew his way around money and definitely knows how to invest. But he was looking for help with his money. I said to him once, “Of all the people I know, you’re in the best position to...
Page 1 of 2512345...1020...Last »